S&P 500 Closes at Record High, Cracks 2000: What’s Next?

By Ben Levisohn

The S&P 500 rose 0.1% to 2,000.02, a new record and the first time the index closed above 2,000. The Dow Jones Industrial Average advanced 0.2% to 17,106.70, its third-highest close ever, while the Nasdaq Composite gained 0.3% to 4,570.64. The small-company Russell 2000 jumped 0.9% to 1,175.17.

The stock market gained despite the release of mixed economic data released today. On a seasonally adjusted basis, the S&P/Case-Shiller Home Price Indexfell 0.1% in June from May, although they rose 0.9% on an unadjusted basis, while durable goods orders jumped 23% in July, though strip out airplanes and orders fell 0.8%. US consumer confidence rose to 92.4 in August, besting forecasts for a reading of 88.5. Interactive Brokers’ Andrew Wilkinson considers the mixed messages:

Generally speaking, consumers indicated that they were more confident about the economy at the present time. As a result the Conference Board’s headline reading of confidence rose to 92.4 reaching its highest reading since October 2007. While the mindset among consumers is buoyant surrounding the present situation, they shied away when asked about their future positions. As a result the expectations index took a step back to 90.9 (-1.0). Fewer consumers planned to buy major appliances in the next six months. Meanwhile, more people indicated that they planned to buy a “new” home over the coming period. Fewer people planned to buy “used” homes. The mix here is important as the existing homes market comprises about 95% of the overall housing market. Corroborating the earlier durable goods report, consumer confidence data points show that progress continues to face challenges as the recovery becomes entrenched.

The S&P 500 is neither overvalued nor undervalued at its current price. The price simply reflects consensus expectations about forward earnings and dividends growth, multiples, interest rates and a fair required rate of return. All these variables are either directly observable or have easy to use empirical based models for parameter estimation. Investors can and should evaluate their expectations against others and market implied realities. Consensus expectations and your own can be too high or too low. They can be overly optimistic or unduly pessimistic- but the price of the S&P 500 is right.

If you think that the expectation of 7% risk-adjusted return is reasonable to bear equity risk, then you should be comfortable with the current valuation. However, the valuation appears stretched unless you trust that the dividend yield or growth rate of dividends will increase, or you are willing to lower your required rate of return…

Capital Economics’ John Higgins thinks the S&P 500 finishes the year at 2,000.

Although the S&P 500 has broken above 2,000 this week for the first time, we doubt that the stock market will go from strength to strength. For now, we are sticking with our forecast that the index will end next year roughly where it is now…

…no recent tightening cycle has featured large-scale asset purchases by the Fed, which are due to be phased out soon. These have given equity prices a big boost in recent years via portfolio rebalancing. As a result, the valuation of the S&P 500 is now more stretched than it was when the Fed first raised rates in six of the last seven major tightening cycles. The exception was in 1999/2000, when tighter policy was soon followed by the bursting of the dot com bubble. Granted, the valuation of the stock market is nowhere near as high as it was then. But it is hard to make the case that equities are attractively valued today in their own right.

About Stocks To Watch

Earnings reports, corporate strategies and analyst insights are all part of what moves stocks, and they’re all covered by the Stocks to Watch blog. We also look at macro issues, investor sentiments and hidden trends that are affecting the market. Stocks to Watch gives you the full picture of the U.S. stock markets, all day long.

The blog is written by Ben Levisohn, a former stock trader who has covered financial markets for the Wall Street Journal, Bloomberg and BusinessWeek.